About the Author

On January 1, 2006, the new Medicare Part D prescription drug
benefit is scheduled to go into effect. At its core is one of the
oddest coverage designs ever created for a health insurance
benefit. The coverage consists of a low initial deductible,
followed by generous reimbursement for remaining front-end
expenses, then followed by no coverage at all for mid-range
expenses, and ending with almost full reimbursement of major
expenses (see Table 1).

Apparently, Congress conceived this odd
design as a way to reconcile the differences between its political
objectives and fiscal reality. Congress's evident political
intention was to win support from seniors by expanding Medicare to
cover one of the largest heath expenses not yet covered by the
program - outpatient prescription drugs. But the fiscal reality is
that the federal government can't possibly afford to cover all such
expenses. The Congressional Budget Office (CBO) projects that, even
without the new program, spending on prescription drugs by or on
behalf of Medicare enrollees in 2006 will total $134 billion, with annual spending
rising to $284 billion by 2013.[1]

Faced with the reality that providing
"everything to everybody" was fiscally impossible, Congress'
political imperative became to provide at least something to most
Medicare beneficiaries. Thus, the resulting coverage design
included a low deductible of $250 and 75 percent reimbursement for
the next $2,000 of each beneficiary's drug spending . Political and
policy considerations also meant that Congress had to provide
additional relief for the small number of beneficiaries with
catastrophic drug expenses, as well as further assistance to
low-income beneficiaries. So Congress set a per beneficiary limit
of $3,600 in out-of-pocket expenses, beyond which Medicare will pay
at least 95 percent of all additional drug costs, and also
established a set of subsidies for low-income beneficiaries to
further reduce their out-of-pocket costs and coverage
premiums.

But the unavoidable result of this
design was that it includes a large "coverage gap" or "doughnut
hole" in the mid-range of drug spending. Once a beneficiary has
spent $2,250 on prescription drugs, with Medicare reimbursing
$1,500 of those costs, he or she will receive no further Medicare
reimbursement until reaching a total of $3,600 in out-of-pocket
drug costs. That means the beneficiary must pay entirely
out-of-pocket for the next $2,850 of drugs, after the first $2,250.
Of course, this "coverage gap" or "doughnut hole" feature of the
Part D benefit design is likely to prove highly unpopular with
Medicare enrollees

Volatile Variables

The interesting question then, is how
might the conflicting political dynamics - particularly,
beneficiary support for generous front-end drug coverage and
beneficiary dissatisfaction with the coverage gap - play out next
year when the Part D benefit is scheduled to take effect? Given
that 2006 will not only be the first year of the new program but
also an election year, it will be a test of whether Congress got
its political calculations right.

The key variables are:

The number of enrollees likely to
perceive that they have benefited from the generous front-end
coverage of the benefit design and/or the program's low-income
subsidies;

The number of enrollees likely to not
benefit at all from the new program;

The number of enrollees likely to
experience the "coverage gap;" and

The timing at which some enrollees will
experience the coverage gap and reach the out-of-pocket spending
limit.

CBO projects that in 2006, out of a
total of 42.6 million eligible Medicare beneficiaries, 29 million
will participate in the new Part D program.[2]
A study conducted last fall by the Actuarial Research
Corporation and the Kaiser Family Foundation, and
using CBO's assumptions, further estimated that of those 29 million
enrollees, 6.9 million would reach the coverage gap, another 15.1
million would benefit from the program's front-end coverage and
low-income subsidy features but not reach the coverage gap, and the
remaining 6.0 million would not have enough drug spending during
the year to benefit from the program at all (see Table 2).

While the ARC/Kaiser study estimates the distributional effects on
the enrollee population of the Part D coverage design and
subsidies, it doesn't offer an analysis of the timing of those
effects. Of particular interest is how the widely discussed drug
"coverage gap" can be expected to effect the enrollee population
over the course of 2006, the first year of the entitlement's
implementation.

To assess the timing effect, one must start with data on the
distribution of enrollees by total drug spending from all sources,
prior to the inception of the new Part D program. By applying the
benefit design to each spending level, one can calculate if and
when beneficiaries within each spending level will reach the
coverage gap and out-of-pocket limit. The distribution of enrollees
by spending level must then be adjusted to account for projected
Part D enrollment and for the effects of Part D subsidies, in order
to generate revised estimates for the number of enrollees in each
spending level. Table 3 shows the results of such an analysis.

The estimates
derived from this analysis (Table 3) are close to those reported by
the ARC/Kaiser study (Table 2) in three instances, including two at
the opposite ends of the distribution. First, both analyses
conclude that about 3 million enrollees will have no drug spending
at all in 2006. Second, the ARC/Kaiser study estimates that 3.1
million beneficiaries will have catastrophic drug expenses
sufficient to trigger the out-of-pocket spending limit in 2006,
while the analysis presented in Table 3 estimates a slightly higher
figure of 3.3 million enrollees. Finally, the ARC/Kaiser study
estimates that 16.1 million beneficiaries will have some of their
drug costs reimbursed by Medicare, but will not experience the
coverage gap, while the analysis presented in Table 3 estimates a
somewhat higher figure of 16.9 million enrollees.

However, the two analyses differ substantially as to the number of
beneficiaries that will experience the coverage gap but will not
trigger the out-of-pocket spending limit in 2006. The ARC/Kaiser
study projects the number of such beneficiaries to be 3.8 million
while the analysis presented in Table 3 puts the number at 5.8
million. The other significant difference is that the ARC/Kaiser
study is able to estimate that 3.0 million unsubsidized
beneficiaries will have drug expenses that do not exceed the $250
deductible and thus will also not have any expenses reimbursed by
Medicare.

These differences in estimates can be attributed to the greater
precision that can be achieved by a more thorough econometric
analysis of the kind conducted by ARC/Kaiser. However, the analysis
presented in Table 3 is still useful for projecting the rough
timing effect of the coverage gap and out-of pocket spending limits
in the new Medicare Part D program. Chart 1 graphs the cumulative
effects of those provisions using the data presented in Table
3.

The Data
Show
With the caveats that the underlying data both likely overestimates
the number of enrollees who will experience the coverage gap in
2006 and lacks sufficient precision to plot smoother curves, Chart
3 does show that some reasonable conclusions can be made about the
dynamics of these provisions.

First, some enrollees will enter the coverage gap during the first
quarter, and their numbers will grow steadily until they peak near
the end of the year. Second, those enrollees with the highest costs
will begin triggering the out-of-pocket limit at mid-year and their
numbers will climb gradually throughout the second half of the
year.

Intuitively, these conclusions make sense. Drug costs for Medicare
beneficiaries with mid-range to high annual drug spending are in
most instances attributable to maintenance therapies - in other
words medicines taken regularly over long periods of time to treat
chronic conditions. Any changes in their monthly drug expenses will
most likely come from adding or switching maintenance therapies.
Therefore, their actual monthly drug expenditures are likely to
closely track any estimate made by dividing their annual
expenditures by twelve. This means that most will enter and exit
the coverage gap on a steady, predictable path over time. The
higher their annual drug expenses, the quicker they will enter and
the quicker they will exit the coverage gap. Conversely, the lower
their annual drug expenses, the longer it will take to reach the
coverage gap and the longer it will be before they exit the
coverage gap by reaching the out-of-pocket limit.

Third, there will be a year-end "pile up" in the Medicare drug
"dough-nut" hole. As the experiences of the different drug spending
cohorts overlap, the number of enrollees in the coverage gap and
the number of enrollees whose drug spending exceeds the
out-of-pocket limit will both "pile-up" towards the end of the
year.

Furthermore, this "piling up" effect will be exacerbated by the
fact that there are more enrollees in the lower-spending cohorts
reaching the coverage gap and out-of-pocket limit later in the year
than there are in the higher-spending cohorts who reach those
thresholds earlier in the year, as can be seen in Table 3.

During the second half of the year, the effect will be somewhat
dampened as those with the highest drug spending exit the coverage
gap by reaching the catastrophic out-of-pocket limit. However,
those in the lower part of the mid-range - with annual drug expense
between $2,250 and $5,100 - will enter the coverage gap beginning
in mid-year but not exit it before the end of the year.

Of course, at the beginning of each year the benefit calculation is
reset to zero and the pattern starts over again.

Conclusion
The data presented in Tables 2 and 3 clearly show that the odd
coverage design of the new Part D benefit is likely to achieve
Congress's intended effect of creating a large number of "winners."
However, the data also indicate that a significant share of
enrollees are likely to be less than thrilled with the effects of
that coverage design.

It is axiomatic among health care policy analysts that those who
benefit from health care changes rarely voice their appreciation
while those who feel disadvantaged by the changes always complain
loudly. For Congress, that will be a problem.

Edmund F.
Haislmaieris a Visiting Research Fellow in
the Center for Health Policy Studies at The Heritage
Foundation.